Houses of Cards

Lessons From the Real-Estate Bubble

By Jo Lynn Orr

It doesn’t matter if they’re made from bubble gum, soap, tech stocks, or subdivisions, the invariable law of bubbles is a simple one: They burst. And when they go, they tend to leave a mess behind. But few, if any, have grown so big or spread their wreckage so far as the vast American real-estate bubble, which began in the mid-1990s and kept inflating through most of the present decade before bursting catastrophically last year.

A culture of irresponsible lending typified by the subprime mortgage craze helped the bubble grow and generated much of the pressure that made it explode. But another factor contributing to the great real-estate bust of 2008, especially in the residential sector, was overdevelopment, says Lary Cowart, Ph.D., interim chair of the Department of Finance, Economics, and Quantitative Methods in the School of Business and director of UAB’s real-estate program. In simple economic terms, the supply of new houses grew so quickly that it far outstripped demand.

“If you look at what has happened in the residential-sales industry in Birmingham, you see that it really began in April 2006,” says Cowart. “Starting in that month, we were continually increasing our supply of houses without significantly changing demand. Consequently, we have about 5,000 more houses on the market now than we would normally need.”

The Loneliness of the Overdeveloped Subdivision

The optimistic expansion of the residential housing market evokes the tag line from the movie Field of Dreams. “You could say that developers were suffering from the build-it-and-they-will-come syndrome,” Cowart says. And in a sense, it worked—for a while. Builders were churning out houses, and sales were booming. The problem was that these sales spikes were fueling an unsustainable upward spiral, notes Cowart.

“I think it started this way: One month sales were up, but supply was up even more, which means that the next month’s sales were pushed even higher,” he says. “And developers ended up building twice as many new homes as they were selling additional homes. They sold 200 more homes in May, for instance, than they did in April; but 400 new homes were added during the same period. That left 200 more homes than buyers. If you continue to do that every month—sell 300, build 600 more—sooner or later you have 10,000 empty houses.

“Right now, there are about 12,500 houses on the market in Birmingham,” Cowart continues. “If you look at March 2005 records, there were only 6,500 houses on the market. So we’ve got something of a glut.” This overproduction peaked in September 2007, says Cowart, but by then it was too late.

There is a way to turn on the lights in Birmingham’s unsold houses—and keep them burning—according to Cowart. “The path out of this overdevelopment is to create jobs,” he says. “Jobs bring in new residents to occupy empty houses.”

An additional 2,500 to 3,000 jobs would create the demand for the extra 5,000 houses on the market in Birmingham, says Cowart—because those jobs would in turn create other employment opportunities. And even with the current sorry state of the economy, Birmingham has advantages, he notes. “One of the very attractive things about Birmingham is that our affordability is pretty good. In California and New York, only 35 percent of the people can actually afford to live there—to buy a house, that is. But in Birmingham it’s closer to 70 percent.”

While it may take time to generate those jobs and rescue the local housing market, Cowart argues that the importance of employment trends should not be overlooked. “What we have to learn from our current situation,” he says, “is that we must maintain the jobs we have and create new ones.”

Big Dreams, Little Vision

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So what will the real-estate industry learn from the bubble? And how could so many people have missed signs that now seem so obvious? “One of the interesting things about the real-estate market is that most of the players are small,” says Cowart. “There’s a large number of small players, and they’re all out there working, but they cannot see the whole market. When sales are not keeping up with production at IBM, they can recognize that and do something about it quickly. In the real-estate market, there’s no one person who is seeing all the data and can say, ‘We have a problem; we’re producing more than we can absorb.’”

Soon, however, UAB will begin sending out graduates with the training to do just that. Cowart started an eight-course real-estate track in the School of Business in spring 2007, and he says the response to the new track has been enthusiastic. “We’re seeing strong demand from students, notwithstanding the bad news about real estate,” says Cowart. “Most of our students are going into the banking industry, and the banking industry obviously needs some well-schooled employees right now.” [For more on UAB’s new real-estate program, see “Real Estate for the Real World.”]